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Since the 2008 housing crisis, foreclosures have dropped to normal levels. The current national foreclosure rate, 1.4% of all homes with a mortgage, is the lowest it has been since March 2008.  Thirty-six states have a foreclosure inventory lower than the national mean, one of which is North Carolina, with a foreclosure inventory of just 0.08%.  But in August 2015 North Carolina passed a bill to protect tenants living in properties facing foreclosed.

The bill largely mirrors the Protecting Tenants at Foreclosure Act, a federal law passed after the 2008 financial crisis.  The federal law expired in 2014 and Congress did not re-enact it.  The North Carolina law’s main provision states that when a buyer purchases a foreclosed property, the buyer assumes title to the property subject to any rights of the tenant currntly living there.  Essentially, if there is a tenant in the property, the tenant has the right to remain there until the end of the lease term or one year from the date the buyer acquired the property, whichever is shorter.  

There are exceptions however.  Buyers looking to move in as their primary residence are excluded, and only have to give the renters 90 days to vacate.  Additionally, the tenant may not be the borrower (who is currently in foreclosure) or the parent, child, or spouse of the borrower.  The tenant must also have a written lease agreement that is not “terminable at will,” meaning the landlord does not have the right to end the lease at any time.  The last requirement for the law to apply is that the rent is not “substantially less than fair market rent for the property.”  If the purchaser plans on using the property as a primary residence, or the tenant has an oral lease or a lease that is terminable at will, the buyer must give the current occupants 90 days notice to vacate.

While the intent behind this law is admirable, it poses significant issues for those who purchase foreclosures and tenants.  One of which is the difficulty in determining whether the law applies to a foreclosure.  First, those buying foreclosures do not necessarily have access to know the status of any tenancies, and generally won't know whether the law is applicable until after the closing.  The buyer will have to rely on the current tenants to learn the details of the lease agreement, whether that lease agreement is in writing, and what the rent amount is.  Depending on the current tenants, it may be impossible for the buyer to get this information before purchasing the property.  This will result in the buyers going into a closing without knowing anything about the current tenants or any lease agreements.  Buyers may bid less for the properties, meaning that prior owners in foreclosure will receive less too, and may be the targets of more deficiency lawsuits.

North Carolina Tenant Protection from ForeclosuresAnother issue in determining whether the law applies is the ambiguity of the phrase “substantially less than fair market rent.”  Is "substantially" 15%, or maybe 25%, or perhaps a whopping 40%?  The term is not defined within the statute itself and the only guidance we have from the law is that it does not include rent that is subsidized or reduced by a federal or state subsidy.  Case law interpreting the federal statute provides little guidance with this issue.  The Court of Appeals of Georgia held that 30% below fair market rent qualified as "substantially below fair market rent;" however, the North Carolina courts may not interpret this phrase the same way.  The one North Carolina case on record for the federal law did not address whether the rent is "substantially below fair market rent."

Then there are the more practical concerns.  First, if the property is not the buyer’s primary residence the buyer will be required to become a landlord to the property’s current occupants.  The buyer, who did not have the opportunity to screen the tenants or do any due diligence on their ability to pay rent, will be stuck with the tenants until the end of their lease term, or a year from the purchase of the property.  Perhaps the tenants treat the property terribly, or are a noisy nuisance to neighbors?

The buyer will also be locked into the rent amount the previous landlord agreed to, as long as it is not “substantially less than fair market rent.”  Outside of the ambiguity of what that term actually means, if the previous landlord charged a rent that doesn’t quite meet the standard of “substantially less than fair market rent” but is still less than what the buyer would like to charge, the buyer has no option but to accept the inadequate rent payments until the end of the lease term or for the next year.  While the buyer is not required to renew the lease agreement, this requirement puts them in the position of not only being unwilling landlords, but also not receiving enough income to cover the expenses associated with the tenancy or the property throughout the duration of the lease term.

The law has great intentions of protecting tenants from being forced out of their homes when the property is in foreclosure, but the ambiguity and uncertainty associated with the law may be problematic for both buyers and the foreclosed owners.

Related Reading:

As Foreclosures Ebb, Bargain Investors Turn to the Age-Old Practice of Tax Lien Investing

Wall Street Ramping Up Its Foreclosure-to-Rental Investments


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